Trading Multiples | Definition | Steps to Valuate Company

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hello everyone hi welcome to the channel of WallStreetmojo
friends today we are going to learn a topic that is trading multiple something
which is really really significant and important when you are doing valuations
of companies or stock and so on and so forth
so let's learn exactly what the concept is all about trading multiples or
trading multiple is nothing but identifying comparable companies
comparable company means all those companies who are in the same industry
literally let's say you're working in pharmaceutical industry and you want to
value that pharma company then you need to take the pure pharma company in the
industry itself and performing relative valuation like an expert to find a fair
value fair value means your valuation of the firm so what exactly is this trading
multiple okay let's begin see trading multiple valuation is
nothing but identifying comp companies it's comparable companies but it's also
known as comp companies and performing relative valuations like export to find
the fair value that is the valuation the you price of the firm the trading
multiple valuation it process starts with first you know you identify you
need to identify the comp companies in the market and then selecting the right
valuation tools so you can say the evaluation tools is the next task and
finally then preparing the table that can provide a easy inferences about the
fair value of the industry and the company so before digging into the
utility of trading multiples first let's take a very simple trading example or
trading multiple example to illustrate how exactly the thing works let's say
that you are comparing between two companies let's say company Y and then
scummy Z at this moment as an investor you only know that the share price the
number of shares outstanding for each company and the market capitalization
because if you have the share price if we have the number of shares then it's
really easy to find the market cap so comparing the share price of Y let's say
the share price I'm indicating it as P which is $10 Per share and for companies
II it's $25 per share you don't understand anything out of this so how
would you tell which company is doing create by looking at the share price is
it possible see that's why you would look for relative value by using trading
multiples first and foremost you will look at the EPS of each company you
found out let's say that the EPS of company Y EPS of company Y is let's say
$5 per share and that of EPS of companies there is let's say $9 per
share so by looking at EPS you come to the conclusion that company Z is making
more money than company y but that doesn't mean that it has benefited to
you or it has given some benefit to you see to find how much you would get out
of the company or how much you will perceive if you would buy them in the
first place you need to look at the most important multiple that's called PE that
surprise to earning ratio see by looking at the period show you you can find the
value or you can find the multiple as price divided by earning per share so
that is control R so you can see it's - let's see how what is the difference so
that it's 2 and 2.77 and now it becomes clear that which
company is more profitable as you as an investor so you would get $1 worth of
earning by paying 1.5 to come me why whereas this is the perfect
interpretation of PE ratio and in case of Z you would get $1 worth of earning
by paying 2.77 to companies in now that means company y is
certainly you can say more beneficial for you as an investor so let's go a
step by step approach let's take a step by step approach for trading multiple
valuation table see in this particular section we'll we'll go step by step and
we'll talk about how each step briefly after going through the whole section
you would get a very clear idea how to use a trading multiples for a valuing
your company a crystal clear idea the step one that starts as you need to
identify as we have discussed the comparable companies in the industry
itself as you can see there are lists of companies and
this are the comparables which will be used we have price market cap so by that
we can receive number of shares and there is an order valuation metric that
is EV that has been used the first question that investor us and how much
we identify the comparable company how would we identify the question is quite
obvious since there are many companies in the industry how would one know which
is the right company so first what you need to do is that you need to look for
you need to look for business mix that's the most important thing in this
business mix okay under the business mix you would see the three things one is
called the product the another is called the service and offered by the company
and the third is the geographical area by which they serve the customer the
second most important thing is that you would see the size of the company under
the size you can choose any or all three determinants like revenue okay then you
have the total assets and or you can say and an or a EBITDA margin very important
see the idea is to find out the right industry right service products and
right trading multiples additionally you know we can we'll be looking in in in
example if possible second say second step
looking at the trading multiple for valuation for trading multiple okay this
is how we are going to value now there are lists of trading multiples that will
evaluate see there are various multiple we can use for value accompany and here
we are going to talk about the same the first and the foremost is EV/EBITDA
now this is one of the most trade most common trading multi but the
purpose of using EV that is enterprise value not only considers the market cap
you can say but it also takes into account also takes the debt into account
even EBITDA also takes that into account and not the immediate cash item and
that's why EV/EBIDTA is the most reliable multiple investor and analyst
analyst used to value the company the right range of EV/EBIDTA is close
enough to 6X to 15X usually in that scenario then we have next in our
list is EV/Revenue now this is also another common multiple that is used a
lot the multiple is applicable to only those situation where
EBITDA of the company is negative now EV/EBITDA is negative EV/EBIDTA
wouldn't be much useful and for the companies that have just started their
journey a negative EV/EBIDTA is a very to common however EV/Revenue
is it a great multiple to be used when two companies have similar revenue but
can be pretty different and how much operate see you can say that EV/Revenue
multiple ranges in close enough to 1X to 3X the next set that we are
going to understand is the p/e ratio now the p/e ratio this multiple is
specifically useful because EBIT has calculated after adjusting the
depreciation amortization you know but there is another common multiple that
investor used to find out about the price they need to pay for the earning a
dollar it is almost similar to equity value to net income it usually should
range around 12 X to 30 X so this are the trading multi you should use the
next step is going to be comparing you need to compare the multiples with the
comparable company compare the multiples with comp companies right this is the
last step of the whole process and in this stage you will look at various
trading multiples of the target company and will compare the comparable
companies now the general matrix to look at are very simple like you know you can
use mean median low or high if a company is multiple is above the mean and
median you can see that we tend to infer the company and may be overvalued on the
other hand if the multiple is below the mean and median we may infer it as
undervalued right so high and low helps us understand understanding the outliers
and the case to remove those if they are too far away from the mean and the
median now there are a couple of things that you need to load while interpreting
the trading multiples were while going through the trading multiple see first
is many trading multiples can mislead you you know it's better if you look for
the forward that's very important forward or trading multiples instead of
looking at the past data second EV/EBIDTA now multiple we just
discussed over here EV/EBIDTA multiple is one of the best use if you
are comparing the target company with big companies okay and for start-up one
of the best multiple is EV/Revenue which we just learned now P ratio that
is a third should be used at all should it shouldn't be used at all now there
are two reason behind it first P ratio are mostly affected by the cap
sources at capital sources and secondly P ratio is calculated by taking the
overall earnings into account and overall earnings include the non ops
that is the non operating charges like write-offs and restructuring extra
charges restructuring charges and some monetization expenses and so on and so
forth thank you everyone

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Trading Multiples | Definition | Steps to Valuate Company

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